There is one thing, however, that is clear to me.
The banking business has been around for a thousand years, it’s the life blood of any economy and it’s not going to go away. This crisis, when it’s all over, will have taken huge capacity out of the international banking and financial business. Those banks that survive this turmoil will be extraordinarily well positioned to do outstandingly well and I think that includes the Canadian banks.
In 1873, there was a financial panic and banking crisis in Paris and Baron Rothschild said the time to buy is “when there is blood in the streets”. Well, we must be getting close.
Booms, busts, bubbles, panics, crashes and bankruptcies – to some extent we’ve seen it all before, but somehow the system always survives, adapts and moves on to bigger and better things and, in time, I am sure it will again.
Also, we should remember that the U.S. economy is;
- the most entrepreneurial
- the most innovative
- the most competitive
- the most flexible and
- by far the most resilient in the world
For two centuries, it has demonstrated time and again an enormous ability to bounce back.
This time it may just take longer.
Will this be the financial crisis to end all crises – not a chance.
Twenty years from now, this crisis will be ancient history and long forgotten, and the young people running the businesses at that time will set out to do the same thing all over again.
Nevertheless, hope springs eternal and I hope the lessons of the past year and a half are indelibly ingrained;
- on central banks
- on regulators
- on Boards of Directors and most especially
- on top corporate management
so that the financial business may once again become an industry of choice for investors.
March 26, 2009
March 25, 2009
Step to recovery
The second key to economic recovery in the U.S. is the consumer and the key to the consumer is housing.
The consumer accounts for about 70% of GDP in the United States. Most recessions over the past fifty years have been caused by excessive inventories or over capacity.
This is different. This is a consumer led recession.
There is too much consumer debt and it won’t turn around until consumers have restored their family balance sheets and are confident once again to start spending. The American consumer has over-borrowed and overspent for a decade and is now tapped out. Irrespective of much lower interest rates and the prospect of lower income taxes, I believe we have moved into a multi-year period of consumer retrenchment and thrift.
The consumer in the U.S. is shell shocked.
Their equity and retirement portfolios are down but, far more importantly, 68% of American families own their own homes and home prices are down by more than 20% and likely to fall further.
If the value of your home drops by 25%, it shakes your confidence.
As a matter of interest the average Canadian carries 2 credit cards whereas the average American carries more than 6.
The average credit card balance per family is $2,000 in Canada and over $8,000 in the U.S. On top of all this, the job market is uncertain. In this environment I expect consumers to pull back and the U.S. personal savings rate, having fallen for more than twenty years, will now start a gradual rise back to the traditional range of 6% to 8% or higher.
The only way consumers can restore their balance sheets is by saving more and spending less – and spending less will delay recovery.
The consumer accounts for about 70% of GDP in the United States. Most recessions over the past fifty years have been caused by excessive inventories or over capacity.
This is different. This is a consumer led recession.
There is too much consumer debt and it won’t turn around until consumers have restored their family balance sheets and are confident once again to start spending. The American consumer has over-borrowed and overspent for a decade and is now tapped out. Irrespective of much lower interest rates and the prospect of lower income taxes, I believe we have moved into a multi-year period of consumer retrenchment and thrift.
The consumer in the U.S. is shell shocked.
Their equity and retirement portfolios are down but, far more importantly, 68% of American families own their own homes and home prices are down by more than 20% and likely to fall further.
If the value of your home drops by 25%, it shakes your confidence.
As a matter of interest the average Canadian carries 2 credit cards whereas the average American carries more than 6.
The average credit card balance per family is $2,000 in Canada and over $8,000 in the U.S. On top of all this, the job market is uncertain. In this environment I expect consumers to pull back and the U.S. personal savings rate, having fallen for more than twenty years, will now start a gradual rise back to the traditional range of 6% to 8% or higher.
The only way consumers can restore their balance sheets is by saving more and spending less – and spending less will delay recovery.
Step 1 to Recovery
So, where does the economy go from here?
My views are no better than anyone else’s except to say that this credit crisis and economic downturn has turned out to be vastly more serious than anyone anticipated every step of the way.
Notwithstanding the major stimulus plan currently under consideration in the U.S., I’m not sure why that should change.
Accordingly, I would anticipate a longer and deeper recession than many observers envisage at this time.
I wish I had a more definitive view, but there are just too many unknowns.
The first step to recovery
We need the stabilation of the banking business in the U.S. and the U.K.
At this stage we still don’t know which banks in the U.S. and Europe are going to survive in their present form – or who is going to own them. To date, various initiatives to repair these banks have failed, but a new plan is under consideration in the U.S. and due to be announced in the near future.
If this fails, there’s a real possibility, even a likelihood, that some of these major banks will have to be nationalized or perhaps put in “conservatorship” a la Fannie Mae and Freddie Mac.
Business owners will have to look to other sources of capital, such as private equity. In Money Magnet, there is a chapter on how to find funds and what they like to see.
My views are no better than anyone else’s except to say that this credit crisis and economic downturn has turned out to be vastly more serious than anyone anticipated every step of the way.
Notwithstanding the major stimulus plan currently under consideration in the U.S., I’m not sure why that should change.
Accordingly, I would anticipate a longer and deeper recession than many observers envisage at this time.
I wish I had a more definitive view, but there are just too many unknowns.
The first step to recovery
We need the stabilation of the banking business in the U.S. and the U.K.
At this stage we still don’t know which banks in the U.S. and Europe are going to survive in their present form – or who is going to own them. To date, various initiatives to repair these banks have failed, but a new plan is under consideration in the U.S. and due to be announced in the near future.
If this fails, there’s a real possibility, even a likelihood, that some of these major banks will have to be nationalized or perhaps put in “conservatorship” a la Fannie Mae and Freddie Mac.
Business owners will have to look to other sources of capital, such as private equity. In Money Magnet, there is a chapter on how to find funds and what they like to see.
Where can I raise capital?
Starting in July, the Ontario government will run a fund to begin investing in clean technology, life sciences, and digital media and communications technology companies.
The money will be doled out over five years and the fund will match small to medium private-sector investments and receive an interest in the companies it backs.
News of the fund comes about a month after a report that found that financing activity in Canada's venture capital market dropped to its lowest level in 12 years in 2008 as the economic downturn choked the flow of funds to small start-up companies.
If you want to raise capital, read Money Magnet to learn how to get the cheque books opening. Read more at Reuters.
The money will be doled out over five years and the fund will match small to medium private-sector investments and receive an interest in the companies it backs.
News of the fund comes about a month after a report that found that financing activity in Canada's venture capital market dropped to its lowest level in 12 years in 2008 as the economic downturn choked the flow of funds to small start-up companies.
If you want to raise capital, read Money Magnet to learn how to get the cheque books opening. Read more at Reuters.
Entrepreneurs get on with it
Business owners do not have the luxury of the Fortune 500 to ask committees to do an analysis and white paper before making a decision (or not). I heard that 99% of registered companies in Canada are SMEs - (small and medium sized enterprises.) That high number is quite astounding but should not have suprised me as I do believe Canada is a great place to start and run your own company.
Naomi Klein stoked a fire with her negative spin on the evil of corporates. I will leave that topic but the smaller companies are just too busy surviving and are surprisingly devoted to their staff. The hardest part of this downturn for many of the CEOs is letting people go.
Private equity in Toronto has played a big role in getting SMEs transformed into professionally run companies who can then operate globally. I believe the credit crisis is part of a larger fundamental shift in power shifting away from large institutions like banks, who used to be the only place to get money to grow companies - along with the public market. I expand on this shift in Money Magnet. Over the past ten years there has been an explosion of private money being invested into companies but these venture capitalists would also get in guide the entrepreneur.
Here's The Economist bolstering the role of the entrepreneur.
Naomi Klein stoked a fire with her negative spin on the evil of corporates. I will leave that topic but the smaller companies are just too busy surviving and are surprisingly devoted to their staff. The hardest part of this downturn for many of the CEOs is letting people go.
Private equity in Toronto has played a big role in getting SMEs transformed into professionally run companies who can then operate globally. I believe the credit crisis is part of a larger fundamental shift in power shifting away from large institutions like banks, who used to be the only place to get money to grow companies - along with the public market. I expand on this shift in Money Magnet. Over the past ten years there has been an explosion of private money being invested into companies but these venture capitalists would also get in guide the entrepreneur.
Here's The Economist bolstering the role of the entrepreneur.
March 23, 2009
Credit rating agencies are broken
I have spoken many times about the credit rating agencies. Their model is broken.
- Pennsylvania Railroad went into receivership in 1970 – rated triple A.
- Venezuela defaulted in 1982 – rated triple A.
Over the past several years lots of structured products were rated triple A only to go to triple C in the blink of an eye.
Rating agencies are paid by the issuer. Why would a buyer of securities rely on a rating provided by the seller.
Companies rate shop. They visit all the rating agencies and give the business to the agency which accords them the highest rating.
Mary Schapiro, the incoming Chair of the SEC, testified earlier this month, “until we deal with the compensation model, we’re not going to deal with a conflict of interest and people are not going to have confidence that the ratings are worth relying on, worth the paper they are printed on”.
In my opinion, rating agencies are dangerous because they provide investors with a false sense of security.
- Pennsylvania Railroad went into receivership in 1970 – rated triple A.
- Venezuela defaulted in 1982 – rated triple A.
Over the past several years lots of structured products were rated triple A only to go to triple C in the blink of an eye.
Rating agencies are paid by the issuer. Why would a buyer of securities rely on a rating provided by the seller.
Companies rate shop. They visit all the rating agencies and give the business to the agency which accords them the highest rating.
Mary Schapiro, the incoming Chair of the SEC, testified earlier this month, “until we deal with the compensation model, we’re not going to deal with a conflict of interest and people are not going to have confidence that the ratings are worth relying on, worth the paper they are printed on”.
In my opinion, rating agencies are dangerous because they provide investors with a false sense of security.
Paul Krugman despairs about the Obama Plan
The policy to get this financial crisis tamed from a raging hurricane is no offering comfort to Paul Krugman. His worries are outlined in the NYT.
Private equity partners with Ontario Government
If you know you will be eating the food that you cook, do you think it would make you more careful how much salt you add? When there is self interest, we human beings are absolutely going to pay more attention.
In the same vein, people investing their own cash into a business are more likely to pick winners.
It is uplifting to see that the Ontario government is recognizing this human trait and is partnering with private equity to invest in up and coming companies.
Karen Mazurkewich, Financial Post, writes about useful government initiatives that support venture capitalists and what entrepreneurs really think of them. Marzio Pozzuoli started his company RuggedCom and recognizes that the VC funds are the most competent at funding early stage companies.
"The best guys to fund the emerging technologies and start-ups are the VCs because they are doing diligence to do the investments," says Mr. Pozzuoli. Earlier this week, the Ontario government announced a new $250-million co-investment fund intended to help companies working in clean technology, life sciences, digital media and information and communication technology. If a venture capital firm invests money in a company, the government will match it dollar for dollar. Another bone to the sector was a new $205-million Ontario Venture Capital Fund created last June, comprised of Ontario government cash and funds from institutional players.
Mr. Pozzuoli says the best program the government has for companies like his is the Scientific Research and Experimental Development Tax credit, which has a federal and provincial component. "We still use it today as a public company."
In the same vein, people investing their own cash into a business are more likely to pick winners.
It is uplifting to see that the Ontario government is recognizing this human trait and is partnering with private equity to invest in up and coming companies.
Karen Mazurkewich, Financial Post, writes about useful government initiatives that support venture capitalists and what entrepreneurs really think of them. Marzio Pozzuoli started his company RuggedCom and recognizes that the VC funds are the most competent at funding early stage companies.
"The best guys to fund the emerging technologies and start-ups are the VCs because they are doing diligence to do the investments," says Mr. Pozzuoli. Earlier this week, the Ontario government announced a new $250-million co-investment fund intended to help companies working in clean technology, life sciences, digital media and information and communication technology. If a venture capital firm invests money in a company, the government will match it dollar for dollar. Another bone to the sector was a new $205-million Ontario Venture Capital Fund created last June, comprised of Ontario government cash and funds from institutional players.
Mr. Pozzuoli says the best program the government has for companies like his is the Scientific Research and Experimental Development Tax credit, which has a federal and provincial component. "We still use it today as a public company."
March 22, 2009
Private equity would be better for AIG
I talk a great deal about the difference in the psychology of investing, in my book Money Magnet. But if you want to see some real life examples of people's behaviour when they invest other people's money, not their own, then take a seat to learn from the drama of AIG. Watch the US government and their tax payers' treatment of one of their "investments" - AIG. Now the American government and many of their nation's tax payers believe they have "given" money to AIG. This delusion is understandable but in fact, the US government has bought shares in AIG making tax payers one of the biggest investors. They hold shares in what was a very successful company. Now they are destroying wealth by braying for blood. Who will want to work at AIG in the next few years - only dolts. There goes AIG to the garbage heap and tax payers will not earn back a cent of profit. Joe Nocero at The New York Times explains why tax payers and government need to understand their position as an investment partner in the business.
In other words, it is in the taxpayers’ best interest to position A.I.G. as a company with many profitable units, worth potentially billions, and one bad unit that needs to be unwound. Which, by the way, is the truth. But as Mr. Ely puts it, “the indiscriminate pounding that A.I.G. is taking is destroying the value of the company.” Potential buyers are wary. Customers are going elsewhere. Employees are looking to leave. Treating all of A.I.G. like Public Enemy No. 1 is a pretty dumb way for a majority shareholder to act when he hopes to sell the company for top dollar.
March 20, 2009
Too much leverage is a bad thing
there is just too much leverage in the financial system. Banks, dealers, hedge funds and private equity firms. Too much leverage. The big U.S. investment banks were, by far, the worst offenders followed closely by European banks.
In April 2004 the SEC granted the five big U.S. investment banks virtually unlimited leverage.
Following this decision, the assets and leverage ratios of the five firms exploded.
In just the four years to the end of 2007, the aggregate assets of these five firms doubled from $2.1 trillion to $4.2 trillion and the average leverage ratio, as measured by total assets to common equity, increased from 23 times to 33 times.
These ratios were “off the charts” – especially when you consider these weren’t investment banking firms at all.
Over a decade these firms had morphed into being gigantic hedge funds, dealing in risky assets and they were financed largely by wholesale money.
They were an accident waiting to happen.
Financial firms love leverage because it can do wonders for your profits and your return on equity in the good times.
Unfortunately, leverage can kill you when business turns down.
Most people do not appreciate the destructive power of leverage. At 33 times leverage, as these five big investment banks were, if your assets drop by just 3.3%, you are out of business. And at 40 times leverage, where some European banks were, if your assets drop by just 2.5%, you are gone. With these leverage ratios, there was zero room for error – no cushion.
Leverage is especially destructive in a deflationary environment.
Asset prices decline, debt remains the same and the equity gets crushed.
In April 2004 the SEC granted the five big U.S. investment banks virtually unlimited leverage.
Following this decision, the assets and leverage ratios of the five firms exploded.
In just the four years to the end of 2007, the aggregate assets of these five firms doubled from $2.1 trillion to $4.2 trillion and the average leverage ratio, as measured by total assets to common equity, increased from 23 times to 33 times.
These ratios were “off the charts” – especially when you consider these weren’t investment banking firms at all.
Over a decade these firms had morphed into being gigantic hedge funds, dealing in risky assets and they were financed largely by wholesale money.
They were an accident waiting to happen.
Financial firms love leverage because it can do wonders for your profits and your return on equity in the good times.
Unfortunately, leverage can kill you when business turns down.
Most people do not appreciate the destructive power of leverage. At 33 times leverage, as these five big investment banks were, if your assets drop by just 3.3%, you are out of business. And at 40 times leverage, where some European banks were, if your assets drop by just 2.5%, you are gone. With these leverage ratios, there was zero room for error – no cushion.
Leverage is especially destructive in a deflationary environment.
Asset prices decline, debt remains the same and the equity gets crushed.
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